Pros and Cons of the Pay-For-Performance Model

Updated July 21, 2022

Implementing a pay-for-performance compensation model in your workplace can increase motivation and productivity amongst employees. In this model, they receive more pay when they meet or exceed performance goals set by managers or the company. Before establishing a pay-for-performance policy at work, you need to consider the benefits and potential disadvantages you may encounter to determine whether it fits your business. In this article, we explain what pay for performance is and provide both the pros and cons of this compensation method.

What is pay for performance?

Pay for performance, also referred to as performance-related pay, refers to company programs that pay employees based on how they perform their job. Companies using pay-for-performance initiatives typically provide guidelines that explain what behaviors or performance evaluation results lead to increased pay. For example, to receive an additional payment, employees must make more sales or manufacture more products within a set timeframe.

Advantages of pay for performance

Providing performance-related pay to your employees can have numerous benefits for your workplace. It can help you meet your business goals while also motivating and incentivizing employees to contribute their best work. Here are some of the advantages provided by the pay-for-performance model:

Establishes company values

When providing goals for employees to achieve, try to align them with your company's overall objectives. By doing that, you give employees a better understanding of their role within the company and why it matters. Aligning these payments with company values also shows the positive behaviors you want employees to exhibit. When employees receive rewards for demonstrating those behaviors, it promotes the continued use of them and creates a more cohesive company culture.

Boosts motivation and morale

While the cause of motivation at work can vary from employee to employee, financial rewards can be an effective motivator. When employees realize that meeting certain performance expectations can result in higher pay, it can push them to work hard and develop their skills to meet those goals. Furthermore, these types of policies can also boost morale at work because it shows employees that you want to see them succeed and reward them for their hard work.

Increases productivity

Pay for performance aligns employees' compensation with their contributions at work, so they will produce more to receive more pay. Often, you will outline goals that you want them to meet within a certain period, which may also improve efficiency as employees try to complete more tasks in less time. This additional productivity results in more earnings for both employees and the company itself.

Offers employees more control

Employees working within pay-for-performance models gain the power to increase their wages. These employees may decide to increase their productivity during certain times of the year, such as around the holidays, to gain some extra money. Having this control helps them feel like they have more power to improve their standing at work, rather than perceiving that the power solely belongs to supervisors. Though this model still relies on performance reviews, employees know they have a better chance of improving their evaluations by meeting specific targets.

Attracts and retains top talent

Having pay-for-performance compensation policies can help a company stay competitive when looking to hire candidates. Potential employees may be more likely to choose a company that offers monetary incentives, and thus potentially higher compensation, for their excellent performance at work. The top-performing employees add more value to your company, so it's important to retain them. When they receive the benefits of this policy, it can persuade them to stay because they know the company recognizes and rewards their abilities.

Provides clarity on raises

In companies without pay-for-performance policies, employees sometimes have trouble understanding what leads to a raise. They may feel that managers base those decisions on intangible factors, such as their relationship. Tying compensation to performance reviews can add clarity and provide tangible reasons. As a manager, you should describe the goals or objectives they need to meet to obtain the raise. Then they understand the specific ways their performance contributes to whether they receive a raise.

Reduces the need for oversight

When you provide employees with the objectives they need to meet to receive performance-related pay, they have a much clearer idea of your expectations. As a result, they may require less supervision at work because they already know what they need to do to contribute to the goals you set forth. They may feel the need to take more initiative to achieve those goals, which again means you do not have to watch them as often to ensure they are doing their job.

Adds flexibility

By evaluating employees on the results they achieve, you can enable more flexibility in how they work. You do not need to focus on how many hours they worked or whether they used a specific method, and the employee also does not need to focus on these aspects. Ultimately, all that matters is whether they achieved the expected results. Employees can concentrate on performing their job in the way that best suits them, rather than trying to complete their tasks using a pre-determined "right" process.

Disadvantages of pay for performance

While the pay-for-performance model can create advantages for your employees and the overall company, it may come with some disadvantages. Understanding these potential outcomes can help you determine if such a compensation method is a good fit for your business. Some possible criticisms of pay-for-performance policies include the following:

Affects teamwork

If employees strive to meet objectives based on their performances as individuals, they may focus less on being a teammate to fellow employees. For example, they might concentrate solely on improving their own skills or productivity rather than assisting a struggling colleague. In some situations, the ability of one employee to fulfill their tasks may rely on the performance of another employee. Conflicts may arise if employees feel that not everyone contributes equal effort. However, they may feel better knowing that those who contribute more receive additional payment.

When setting objectives, you may want to include team-based measures into your performance evaluations to highlight their importance. This tactic can help maintain a high level of collaboration and ensure that employees see the value in helping one another achieve goals. While you want to establish cooperation among your employees, remember that healthy competition can still be a great motivator for them.

Puts focus on the quantity of work

When determining the objectives to tie pay raises to, it may be easier to use quantifiable measures. For example, you might tell employees that they need to make a certain number of sales during the quarter to receive the bonus. However, this may lead employees to focus more on the quantity of work they contribute rather than the quality of that work.

To help avoid this, you can explain to employees that you also expect a high level of quality along with meeting the goals. Set these quality standards at the same time as your quantity goals to ensure they work toward all your expectations.

Leaves possibility of subjectivity

In a pay-for-performance model, the compensation relies on the performance reviews received by employees. As a manager, you can objectively rate whether employees met quantifiable measures or goals. However, less quantifiable skills or values such as communication, creativity or teamwork may be more subjective. Let employees know that there may be some subjectivity in their performance reviews, so they know what to expect from their reviewers. You can also determine how to weigh these measures with the more objective ones to ensure more balanced evaluations.

Makes changes more difficult

Once you implement this program, employees who enjoy the benefits will get used to having them. As a result, making changes to or ending the program can become more complicated. If you need to make such decisions, carefully consider the impacts that potential changes could have on employees, and clearly explain your reasoning to them. Even if they feel disappointed, establishing open and honest communication can help maintain trust in your relationship.

If you decide to start a pay-for-performance program, consider having trial periods to test what payment amounts or goals work best for productivity. By testing out the program first, you potentially avoid having to make changes later.

Highlights potential deficiencies

While evaluating the performance of your employees, you may notice that some do not meet certain expectations because they do not have sufficient training, knowledge or experience. Therefore, you may need to implement additional training or resources to provide everyone with the same set of skills or abilities.

While that may add costs, it can also further improve the productivity of your team by ensuring everyone has the qualifications needed to achieve your goals. Before using the pay-for-performance model, you may want to assess the abilities of your employees to make sure you can use a fair evaluation system.